Article provided by WealthCounsel;
Content edited and modified by Bennie A. Wall, Esq.
The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) and its successor, the SECURE 2.0 Act of 2022, have brought significant changes to retirement planning. While much attention has been on retirement accounts, few have explored how SECURE 2.0 affects 529 plans. Here’s what you need to know:
Understanding 529 Plans
A 529 plan is a tax-advantaged investment vehicle designed to save for a beneficiary’s educational expenses. Contributions are made with after-tax dollars and grow tax-free. Withdrawals for qualified educational expenses—like tuition, fees, room and board, books, supplies, and up to $10,000 for student loan repayments—are also tax-free.* Nonqualified withdrawals may incur income taxes plus a 10% penalty, though exceptions apply.
*Note: Some states do not use the same definition of qualified expenses for state income tax calculations.
Strategic Funding and Overfunding Considerations
Many families use their annual gift tax exclusion (currently $18,000 per individual in 2024) to fund 529 plans. Alternatively, you can accelerate contributions by front-loading up to five years of contributions into a single transfer, allowing for up to $90,000 without using your unified transfer tax exemption.
Families should be careful to not overfund a 529 account. Upon completion of education surplus funds may remain in the 529 plan, especially if a beneficiary receives scholarships. Traditionally, accessing these surplus funds involved facing income tax and penalties or transferring the account to another eligible beneficiary. This is why proper planning with financial and tax advisors is imperative to ensure efficient funding and to mitigate risks of overfunding.
SECURE 2.0’s Innovative Provision: 529-to-Roth Rollover
A key feature of SECURE 2.0 is the ability to roll over surplus 529 funds into a Roth IRA for the beneficiary. This strategy not only jump-starts retirement savings but also helps manage the risk of overfunding educational accounts. As of 2024, up to $35,000 of unused 529 funds can be rolled over tax-free into a Roth IRA.
Understanding Roth IRAs
A Roth IRA allows for tax-free growth and withdrawals after age 59½, provided the account has been open for at least five years. Early withdrawals may have exceptions, offering flexibility in financial planning.
Considerations for the Rollover
Before initiating a 529-to-Roth rollover, one must ensure:
- The Roth IRA is in the beneficiary’s name.
- The rollover is done plan-to-plan or trustee-to-trustee.
- The beneficiary earns income equal to or greater than the amount being transferred.
- Annual Roth IRA contribution limits are observed.
- The 529 plan has existed for at least 15 years.
- Contributions (or earnings on contributions) within the last five years are not rolled over.
- A lifetime maximum of $35,000 per beneficiary applies.
Is This Strategy Right for Your Loved Ones?
SECURE 2.0 offers a strategic path to repurpose surplus 529 funds for retirement planning, potentially minimizing taxes and penalties while securing the beneficiary’s financial future.
Navigating these opportunities requires thoughtful consideration of your family’s financial goals and circumstances, so consulting with your financial advisor and tax professional is essential before integrating this strategy.
